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IRS Guidance on HEART Act Suggests Need for Plan Amendments

Congress enacted the Heroes Earnings Assistance and Relief Tax Act of 2008 (the "HEART Act") to expand the rights of employees killed or disabled while in military service. Fourteen years earlier, Congress passed the Uniformed Services Employment and Reemployment Rights Act of 1994 ("USERRA"). While that law provided reemployment and related rights with respect to pension, profit-sharing and 401(k) plans, it did not provide any protections for former employees who were killed or became so disabled that they could not resume their former employment.

On January 21, 2010, the IRS released Notice 2010-15 to provide guidance (in Q & A format) on HEART Act provisions relating to plan qualification and income tax issues for the employees and beneficiaries. The HEART Act imposes mandatory requirements on pension plans, and also provides several options for treatment of military service for former employees killed or disabled. This article will address both the mandatory and optional provisions of the HEART Act that apply to pension plans.

The Heart Act adds several sections to the Internal Revenue Code ("IRC") affecting defined benefit plans. The only mandatory rule is contained in new Section 401(a)(37), which requires that a qualified plan include provisions concerning the way certain benefits are calculated with respect to a participant who dies while performing qualified military service.1 The effective date is for deaths and disabilities occurring on or after January 1, 2007.

Death Benefits

Section 401(a)(37) requires that a plan provide that the survivors of a participant who dies while performing qualified military service are entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. The plan is required to provide vesting credit for qualified military service, but is not required to provide accrual credit. Additional benefits are anything that would be provided under the plan if the participant had resumed employment and then terminated employment on account of death. This includes accelerated vesting, ancillary life insurance benefits, and other survivor's benefits such as pre-retirement survivor's annuity that are contingent on a participant's termination of employment on account of death. (Q&A-1 of Notice 2010-15)

If death benefits are based upon the accrued benefit, section 401(a)(37) does not require that additional accruals be imputed for the period of qualified military service when determining the death benefits.

Service credit for vesting purposes must be provided for the period of a deceased participant's military service. (Q&A-3) Section 401(a)(37) only applies if there are reemployment rights. This is determined by USERRA. (Q&A-4)

Optional Amendments

New section 414(u)(9) of the IRC and IRS guidance also allow plans to provide accrual credit to deceased and disabled veterans and vesting credit to disabled veterans for their period of military service. Note: A disabled individual, actually re-employed under the USERRA provisions, will receive accrual and vesting credit for military service. The credit for military service for vesting and/or accruals for deceased former employees and non-reemployed disabled veterans applies only if all individuals who die or become disabled as a result of performing qualified military service are credited with service and benefits on reasonably equivalent terms. The effective date for section 414(u)(9) is for deaths and disabilities occurring on or after January 1, 2007.

Because the application of section 414(u)(9) is permissive, it can be applied as of any date on or after January 1, 2007. (Q&A-5)

Although a plan must provide vesting credit for qualified military service to a participant who dies in such service, it need not provide vesting credit for a disabled participant. If the plan counts for benefit accrual purposes the qualified military service for a participant who becomes disabled while performing military service, the plan does not have to credit that service for vesting purposes. However, the plan may credit the service for vesting purposes pursuant to other applicable rules, including section 1.401(a)(4)-11(d)(3) of IRS regulations concerning the nondiscrimination rules and imputed service.

Other Provisions

Section 105 of the Act amended the IRC to add section 3401(h) and section 414(u)(12). New section 3401(h) provides that "differential wage payments" are wages for income tax withholding. In general, "differential wage payments" are payments by the employer with respect to any period during which the individual is performing military service while on active duty for more than 30 days. Prior to this change in law (which is effective for payments made after December 31, 2008) such payments were not included in wages.

Cheiron observation: This has the effect of taxing and requiring withholding on the payments and makes it easy to treat the amounts as compensation for pension purposes.

Section 414(u)(12) clarifies the treatment for pension purposes of differential wage payments. These changes apply to years beginning after December 31, 2008. Under section 414(u)(12), for purposes of applying the IRC to a retirement plan:

An individual receiving differential wage payments is treated as an employee of the employer making the payment;

The differential wage payment is treated as compensation, which the plan may or may not take into account for pension purposes;

The plan is not treated as failing the nondiscrimination and coverage rules as a result of providing the extra pension credit. The pass on satisfying the various nondiscrimination rules, etc., applies only if all employees of the employer performing military service as described in section 3401(h)(2)(A) (which picks up the more than 30 days requirement) are entitled to receive differential wage payments on reasonably equivalent terms and, if eligible to participate in a retirement plan maintained by the employer, make contributions based on the payments on reasonably equivalent terms.

Cheiron observation: This means a defined benefit plan that provides benefits based upon differential wages will have to treat employees performing military service in a similar fashion.

The treatment of differential wage payments as compensation for pension purposes is not mandatory.

Timing of Plan Amendments

All qualified plans will have to be amended for the changes made by section 104(a) of the Act, which added section 401(a)(37) to the Code. Under section 104(d)(2) of the Act, for a non-governmental plan, the amendments are to be made no later than the last day of the plan year beginning on or after January 1, 2010. For a governmental plan, it is the last day of the plan year beginning on or after January 1, 2012, rather than 2010. However, the plan must be operated in accordance with section 401(a)(37) and the amendment must be retroactive.

Action Items

The HEART Act made changes that affect all defined benefit plans. Both plan documents and plan operation need to be reviewed to see what has been done to date, and what changes are needed this year.

Required modifications for defined benefit plans: Review plan documents for compliance with section 401(a)(37) and make amendments as necessary in light of the new guidance. Modify plan operations immediately, if needed, to pay benefits with respect to participants who died while performing qualified military service in compliance with the law and the new guidance.

Optional modifications for defined benefit plans: Determine whether the plan has credited, or wants to credit, benefit accrual service for those who died or became disabled while performing qualified military service. Make decisions about whether the plan will treat differential wages as compensation (if not already made). Check that all employees performing military service are entitled to receive differential wage payments on reasonably equivalent terms. Make any necessary changes to the plan document or plan operation.

See other timely articles in our Spring Client Advisory.


1Section 104 of the HEART Act made changes to sections 401(k), 403(b) and 457 of the IRC, so that all 403(b) annuities and 457(b) plans have to satisfy section 401(a)(37). Thus, section 401(a)(37) applies to all qualified plans (private or public), 403(b) annuities, and governmental eligible deferred compensation plans under section 457(b).

 
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